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Oh what a relief it is.

For state finance it was not the best of yeas, nor the worst of years. Most states finished their budgets earlier than usual, and almost every state did so before the new fiscal year began. Most state budgets balanced last year, even if only just. Most budgets will stay in balance in this fiscal year, although slow national economic growth will keep the margin of safety small. Some states built up reserves a little in the course of FY 1993, or paid off deficits rolled forward from the year before. Although familiar long-term problems continued to plague legislators, tax increases, for a change, were very small.

All in all, it was a comfortably mediocre, unexciting year for state finances, bringing the kind of relief a bad sailor feels after stepping from a pitching, rolling boat onto a nice boring dock.

Which is not to say there haven't been some surprises, or that the long-term prospects of state finance are comforting. It's probably best to view 1993 legislative sessions as a pause before rejoining the storm. Some straws that may show which way the wind is blowing:

* In a decision contrary to the national practice of the past 30 years (or more), California replaced a substantial share of state funding for elementary and secondary education with funding from local taxes, to the tune of $2.6 billion. The Legislature did this by shifting that amount of property tax collections from county, municipal and special district governments to school districts.

* Tennessee pulled out of Medicaid, creating a state plan known officially as TennCare but to statehouse wits as Nedcare (for its inventor, Governor Ned McWherter). The plan uses federal waivers, state and private funding and a generous federal match to extend health care to the uninsured population of the state and to replace most Medicaid programs. The expectation is that the broader plan will cost federal and state governments no more than the Medicaid programs it replaces. This was only one example of the new health care systems that states are experimenting with (see the August issue of State Legislatures for others). "There's enough money in the system to provide the care the indigent and uninsured need," says House Majority Leader Bill Purcell. "It's a question of distributing it properly, and that's what this program does."

* Colorado and Oklahoma began a smooth, if not painless, adjustment to a future without state tax increases. New constitutional amendments in both states in effect require voters to approve any tax increase that the legislature passes. (Colorado's provisions also apply to county and municipal taxes.) Lawmakers in both states expect voters to turn thumbs down on tax increases. "The role of legislators has changed," says Oklahoma Senate President Pro Tem Bob Cullison. "We'll meet and cut services. There will never be any more money."

* Michigan lawmakers, ending years of public frustration over property tax relief, repealed all the local property taxes used to support education-$5.6 billion worth. Local property taxes have been the mainstay of public education in America since Massachusetts required the establishment of public schools in the mid-1600s. Proponents hope that an innovative method of financing education will emerge, and point out that rebuilding school funding policy from the ground up will prompt a reassessment of many things--the role teachers' unions play in public education, the value of alternatives such as choice of schools and chartered schools, and finance equalization policies. "I want Michigan to become the education laboratory of America," says Governor John Engler.

For most states, the themes of the 1993 legislative sessions were familiar. If there was one thread common to all 50 states it was the need to accommodate substantial growth in corrections and health care costs within practically stand-still revenues.

Thirty-eight states reported on their budgets in time to be included in the research for this article. They report rapidly growing corrections expenditures, partly because new prisons are coming into service. Such is the case in the state of Washington, which will increase corrections expenditures 29 percent for FY 1994 in order to fund 1,484 new beds. Nationally, the appropriations increase is almost 11 percent, up from a 7 percent increase for FY 1993.

Medicaid did not increase at as rapid a clip as corrections, or as fast as in previous years. Abe Lackman of the Senate Finance Committee staff in New York says Medicaid was good news in that state--for the past four years it grew at an annual 20 percent rate; for next year the rate is down to 4 percent. Ohio fiscal staff report, perhaps ironically, that Medicaid cost is under control--only 10 percent or 11 percent growth for next year.

There are several reasons Medicaid growth is slowing a little. Increases in the past two or three years were stimulated by new federal programs to expand services and by states' enthusiastic adoption of "provider taxes" which tended to increase state funding, not merely replace other sources of funding. But new federal requirements are now phased in, and adoption of provider taxes came almost to a halt in 1993. (New provider taxes created in 1993 will raise $191 million, as opposed to the $1.8 billion that new taxes passed in 1992 raised for FY 1993.)

The average increase in FY 1994 appropriations for Medicaid was 7.5 percent, however, and the amounts that were appropriated may not meet needs. That has been the pattern in recent years. For FY 1993, for example, the amount originally budgeted was only 62 percent above the previous year's spending, but by the end of the fiscal year, spending had grown by 17.6 percent over the previous year's amount. States tended to underestimate caseload growth during the recession and its aftermath, and possibly have underestimated inflationary increases in Medicaid costs.

These growth rates put pressure on the rest of state finance. States expect, on average, that their general revenue collections will grow only 2.8 percent next year, far below rates of increase for corrections and Medicaid. Further pressure comes from increases for elementary and secondary education, for which appropriations also tend to grow faster than general revenue collections for FY 1994. How is this possible?

Part of the answer lies in what has been happening to state funding for higher education. It actually fell from 1992 to 1993, and the recovery in this year's appropriations only restores it to the 1992 amount. Funding for public colleges and universities is shifting from taxes toward tuition and fees. Recently the shift has become dramatic.

One measure of the shift is that for three years in a row the increase in funding for corrections has been more than the increase for higher education--more new money goes to corrections than to education.

A more ominous shift appears in a comparison of state funding for Medicaid and for higher education. For years higher education has been the ranking beneficiary of state general fund appropriations after K-12 education. That remained true through 1992. In FY 1993, Medicaid spending edged out higher education for second rank, and for FY 1994 total Medicaid expenditures from state sources will be 22 percent higher than spending on higher education.

Higher education is not the only area of state budgets to feel the pinch. Aid to Families with Dependent Children has tended to languish for a number of years. An average increase of 2.3 percent for FY 1994 does little more than restore cuts made for 1992, when on average appropriations fell by 2.2 percent. At least 11 states have reduced appropriations or have held them constant from last year, including such large states as Michigan and New jersey

Cutting budgets for some state activities in order to shift money to other areas helps hold total spending down. Slow economic growth and resistance to taxes have made this a way of life for state government in the last few years, and the results show up in the overall picture of state finances.

States practiced very careful budget management throughout FY 1993 in order to keep things in balance. When NCSL did its midyear survey of budget conditions last December, almost half the states reported that revenue shortfalls or budget overruns had already brought budget cuts or that cuts were likely to occur soon.

On a national basis, that attention kept budgets in line: State general fund expenditures for 1993 came in about $1 billion or 0.4 percent over target. This kept them within revenues, which were about 0.7 percent over target. Despite a better-than-expected revenue performance, budgets in many states would not have stayed in line in FY 1993 without some reductions in the course of the year. Total state balances at the end of the year were up a little from the end of FY 1992, representing 3.7 percent of state expenditures instead of 1.2 percent (when the two states that ended their '93 fiscal year with deficits are left out of the calculation). Reporting states expect revenue growth of less than 3 percent over the coming year, and will use up some of their carryover to fund expenditure growth of slightly above 4 percent.

These figures summarize how undramatic most state finances have become. The payoff is that tax increases almost disappeared from the state scene in 1993. The most striking policy change is the Oregon legislature's submission of a 5 percent sales tax to the voters, something it has done a number of times before. The difference this time is that there is a chance the voters will approve it. Most other major tax decisions reflected the slow growth of the national economy since the recession, either business tax changes that are designed to accelerate growth or the extension of temporary taxes that were scheduled to expire.

A number of states enacted what were intended to be temporary tax increases in 1990 and 1991 in the expectation that economic recovery would allow the increases to expire in a few years. In some states this demonstrated more optimism than has turned out to be warranted. Whether decisions to extend temporary taxes count as tax increases depends on who's doing the counting. On the one hand, taxpayers will not pay more than they did in the past--taxes stay at the same level instead of being reduced. On the other hand, an extension means a lost tax reduction. Examples:

* California extended for six more months a half cent sales tax that was scheduled to expire on July 1, 1993. The renewal will provide aid to local governments that are losing revenue because of the decision to transfer $2.6 billion from local property tax collections from general government to education.

* Illinois made temporary personal and corporate income tax hikes, first approved in 1989, permanent.

* Maine set its sales tax rate at 6 percent, making a temporary rate increase permanent, but allowed personal and corporate income tax surcharges to expire.

* New York again postponed previously scheduled reductions in personal and corporate income tax rates.

* Vermont allowed a temporary sales tax increase to expire in its regular legislative session, along with a personal income tax surcharge, but changes in the revenue forecast, for FY 1994 convinced legislators in a special session to continue the higher sales tax rate.

A lot of tax activity in 1993 adjusted business taxes in the hope of stimulating economic growth. Only Washington enacted a significant increase, as opposed to extending existing temporary taxes. The state's changes in the business and occupations tax are intended to bring in more than $200 million in new revenue in FY 1994.

There was also one textbook example of revenue-neutral business tax reform: New Hampshire broadened the base of its business profits tax, reduced the rates and repealed a filing fee and one industry-specific tax.

But most tax changes that concern business were intended to improve states' competitive positions. The most expensive new tax benefit for business was the Texas Legislature's decision to phase out its state sales tax on purchases of manufacturing machinery and equipment, with a first-year cost of $318 million. This is an important area of state tax competition: At least 27 states had previously enacted such exemptions. Louisiana phased in a corporate tax credit for property taxes on business inventories, and New Jersey designed new tax credits for additional investment in equipment, for employment growth and for research and development. Tennessee adopted a one-time $2,000 tax credit for each new full-time employee for businesses that add 25 jobs or more. Arizona reduced the sales tax on commercial leases and telecommunications charges. Changes like this show that state tax competition continues unabated; and that pressure on collections has eased enough to let states experiment. But over all, tax policy was a sideshow in 1993.

Supposing that state analysts are right in predicting moderate but adequate revenue growth, and moderate but controlled expenditure growth, where will the interest lie in state finances in the near future? What are issues to watch?

First of all, there are the old standbys of health care finance and corrections spending. Even if we see a new federal design for national health care, notes former New York Assembly Majority Leader Jim Tanon, "They need our money to make this thing work." And it's likely that corrections spending will continue to grow as a share of state spending.

The real action in 1993, though, and the harbinger of future issues, is state-local relations. One reason is that states have reduced aid to local governments in recent years as a measure to help balance state budgets. Another is that urban budgets suffer from the same strains as state budgets--slow revenue growth, burgeoning costs, tired taxpayers. A third reason is that falling values for commercial property are hurting local property tax collections. And a fourth is that state tax limitation movements tend to fall hardest on local government finance.

Cities' fiscal conditions remain precarious, according to the National League of Cities' annual report on the subject. About half of the cities surveyed (ranging from New York and Los Angeles to River Falls, Wis., and Picayune, Miss.) spent more than they collected in general funds in the last two years. Two-thirds expected their condition to deteriorate in FY 1993. Many emphasized the role of unfunded federal and state mandates in injuring their budgets and in destabilizing local economies. Making the problem worse, the report contends, is that state aid to cities has begun to fan after years of stability in the late 1980s.

One root of the cities' problem is declining commercial property values, now working their way through the assessment process to reduce property tax collections or shift the burden to the politically sensitive area of owner-occupied homes. Kimberly Edwards of the Government Finance Group in Arlington, Va., who has been researching the subject for the Urban Land Institute, says, "In the 1950s and 1960s, regular growth in property values fueled urban finance. It's no longer there. They're shifting to fees and charges. And as states cut back on aid, the buck is stopping for the cities."

Another angle to this growing issue emerges in states that have tough tax or expenditure limits in effect for state governments. In the two newest additions to that list, Oklahoma and Colorado, legislators think that the harshest long-term effects will be local. Senator Cal Hobson of Oklahoma says, "In the long run, we're likely to pull state dollars back from counties and cities. We have to focus on the things that only the state can do." House Speaker Chuck Berry of Colorado contends that about the most ominous feature of Colorado's new tax-limitation constitutional amendment (Amendment 1) is the provision that lets local governments turn mandated services back to the state unless the state funds them. "This could lead to war between state and local government in Colorado," Berry warns. "I don't think we'll see war in Oklahoma," Speaker Glen Johnson of that state says on the subject, "but many legislators think the state comes first."

California demonstrated the kind of hardball politics that a tax limitation can produce when state government moved $2.6 billion in property tax collections from county and municipal governments to school districts in order to cover a reduction in the amount of state revenue sent to the schools. County governments are suing the state in the hope of having the old distribution of property tax collections restored. The San Diego Union says, "The state's tax grab has put in peril county services throughout the state." All of which lends credence to an observation California legislative staffer Peter Schaafsma made at NCSL's Annual Meeting: Tax limits seem to lead to dysfunctional governments. Hal Hovey, the editor of State Budget and Tax News, commented, "If asked whether such a shift could occur so quickly and overtly in any state, I would have said never."

State-local relations in Oregon elicit exaggerated language as well. "Impasse doesn't begin to describe it," says one legislative staffer who understandably wants to be anonymous. "Blood on the floor comes closer." In 1990, Oregon voters amended their constitution to require drastic cuts in property taxes for schools with state government told to make up the funding. The full effect is about to hit, forcing action in the 1993 legislative session .@to resolve a potential $1.2 billion deficit in the coming biennium. Among the solutions for the short run have been massive cuts in state spending. The solution for the long run has been the creation of a state sales tax of 5 percent (Oregon does not now have a state sales tax), earmarked for education and subject to the voters' review in November.

How can state budgets be summed up as the new fiscal year gets under way? It's a good sign that there's no quick summary. Things are getting back to normal after years in which the simple necessity to balance the budget overshadowed every other policy issue. It looks like state budget issues are returning to where they were when the recession disrupted finances in 1990--concerned with corrections, concerned with Medicaid, and on the verge of coming to grips with important questions of state-local relations. These are fiscal issues that reflect policy issues at the very center of government--the public health and safety, and the division of responsibility for delivering public services in a state. In some form they're always near the top of a legislative agenda. And it's a relief to have some of the fiscal pressure off so that these issues can be addressed on their merits.
COPYRIGHT 1993 National Conference of State Legislatures
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Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:state budgets
Author:Snell, Ronald K.
Publication:State Legislatures
Date:Oct 1, 1993
Previous Article:States have a role in Clinton reforms.
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